Netflix: Still the Short of the Century

by Lawrence Meyers | November 3, 2011 11:14 am

Netflix: Still the Short of the Century

It wasn’t that long ago that Netflix (NASDAQ:NFLX[1]) was destined to become a category killer. Its disruptive business model of delivering DVDs by mail coupled with its availability of long tail content became so successful that it brought down mighty Blockbuster Video. But a funny thing happened on the way from a stock price of $8 to $300 — Netflix itself began to fall apart.

Technology caught up with Netflix — then blew past it — and along with it came a different way studios permitted content to be used. Netflix, or anyone else, can purchase a DVD and rent it out as often as it likes. However, streaming content has to be licensed. The world started to move toward streaming content, and it still is. NFLX simply does not have the fiscal resources to license enough material to remain competitive, much less a category killer.

Investors need to understand that DVDs will be gone within five years, and more likely, three. Just like CDs have given way to digital files, so will film and television. Netflix’s DVD business will be dead, and it only will be able to rely on streaming — and NFLX at least realized this when it split up its streaming and DVD businesses[2].

The problem is that streaming licenses are incredibly expensive. Multi-year deals can cost hundreds of millions and, more likely, billions. Netflix simply does not have enough cash on hand, and it won’t generate enough cash flow from its current business, to afford the content it needs to stay competitive.

Stay competitive with whom, you might ask? Try Apple (NASDAQ:AAPL[3]) and Amazon (NASDAQ:AMZN[4]). And how long do you think it’ll be before Google (NASDAQ:GOOG[5]) gets involved in streaming content? Amazon has $6.3 billion in cash and $1.8 billion in trailing 12-month free cash flow. Google has $34 billion in cash and $6.9 billion TTM FCF. Apple has $28 billion in cash and $29 billion in TTM FCF.

And Netflix has $350 million in cash and $270 million TTM FCF.

Which company do you think is the odd man out?

Even if Netflix could compete, which company do you think will have the best streaming technology? Best advertising? Best pricing? If this is starting to sound like a commoditized business, it’s because it eventually will lead to just that, which also will squeeze margins. Netflix won’t even be around by then.

So, yes, I am not only saying Netflix is a “short,” but it is a guaranteed zero in my humble opinion. It won’t happen right away, but it will happen. And there are other things that simply aren’t helping its case.

Netflix’s entire disclosure process is not transparent. Whereas 99% of public companies release earnings, then hold conference calls and open the field to questions from analysts, Netflix insists on having questions in advance. It doesn’t disclose exactly how much its streaming content deals are for — the media just takes guesses, and one must look at off-balance sheet obligations to divine exact amounts. And when you look at those numbers, you realize Netflix has to come up with an awful lot of cash each and every year going forward to hold onto those deals.

Netflix is a goner. The only question is whether you want to wait for NFLX to tick back up a bit and then short, or short it now.

As of this writing, Lawrence Meyers did not own a position in any of the aforementioned stocks. He recently closed out a short position in NFLX at $115, having shorted it at $252 and $210.